Notes From Underground: Pour a Yamizaki, Enjoy 30 Minutes of Harris and Crudele

This morning I had the pleasure of sitting with a professional trader and discussing several themes that have coursed through NOTES FROM UNDERGROUND for the past several months, if not years. In staying with the Crudele hit I want to spend some time on offering some views on the significant flattening of the 5/30 curve during the last few weeks. More importantly, the 5/30 curve broke out to new multi-year lows, blowing through the previous low of 100.98. Today we closed at 99.5. The 2/10 curve was very stable and closed at 82.5 basis points holding above last weeks lows. Why is the more SPECULATIVE-oriented curve flattening more than the conventional investment directed curve?

My theory is that the 5/30 is contracting in the face of the FED shrinking the balance sheet because, according to the New York Fed’s 2016 domestic open market operations report, 39 percent of its portfolio is in Treasuries with less than three years to maturity, with about another 20 percent maturing in three to six years. The belly of the curve today (3-7-year sector) saw yields bid higher after New York Fed President Bill Dudley justify the FED‘s rate increases. Dudley said it’s because of the prospect of wage inflation due to the NAIRU model. If Dudley and other FED voters are correct, then the market is thinking that rate hikes are coming. More importantly, if the FED‘s efforts to shrink the balance sheet results in shortening its duration holdings, then most of the activity will be in the five-to-10-year part of the curve.

If the FED is indeed wrong in presuming that wage inflation will arrive soon then buying 30-year bonds with a higher yield will prove to be a very profitable trade. Also, I propose this thought: If the FED is adamant that the curve should steepen in the shadow of an increased velocity of wage inflation will the FOMC start unloading greater amounts of the assets it hold in an effort to force a steepening of the curve and thus prove its models to be correct. Central banks have been given the massive powers of market price manipulation. Enjoy the interview.

***A quick note on Greek debt. The Greek yield curve has gone from an inverted 120 basis points to the current level of 130 basis points STEEP as Greek two-year yields have fallen to below 4.5%. It’s a massive move and reflects the financial markets’ understanding that Greece will not be allowed to default on its debts or even under take a massive restructuring. (Not yet anyway.) Greek two-year yields at 4.5%?!? The power of central banks indeed. President Trump has been advised not to go to war with those who buy INK BY THE BARREL (the media). I would offer similar advice to the financial markets as they tangle with the global central banks’ printing presses.

shocked–that has been the traditional way to analyze the curve but with the massive manipulation by the central banks it is difficult to know which is what Santelli has been challengingthe traditionalists with–as he said to me off camera–“you can’t have it both ways”—but for those saying that it is the impact of the central bank purchases they had better be correct.An interesting development today was a quiet announcement by the IMF that they would make dollars available to avoid any stress in the global funding market.In picking up from a blog ten days ago–the Nasdaq 100 sent a powerful signal and today’s late sell off after the ridiculous and widely hyped Paul Ryan speech –this market has gotten very interesting from an equity stand point.